Fed Report Cites Office Loans as Potential Economic Vulnerability

The Federal Reserve Board’s semiannual Financial Stability Report, April 2024

Potential losses from certain office real estate loans are an economic vulnerability within the U.S. financial system—yet considered less of a threat than last year, according to the Federal Reserve Board’s semiannual Financial Stability Report. The Fed report noted that if inflation persists and higher interest rates linger during the ongoing, post-pandemic adjustment to remote work, a wave of maturing loans could pose CRE refinancing risks for regional U.S. banks. (Fed report | Bloomberg and Reuters, April 19)

Office Sector Risk

  • The financial stability report focused on four areas of risk, including asset valuations. CRE stress was the third most cited risk, moving down from second in last October’s survey. (KPMG, April 22, 2024 and Roundtable Weekly, Oct. 27, 2023)
  • This month’s Fed report also acknowledged unique strains on CRE, especially in the office sector, “where vulnerabilities have mounted in the post-pandemic period.”
  • The report added that continued economic pressures could reduce investor risk appetite and lead to a “more pronounced correction in commercial property prices.” This, in turn, could “reduce the willingness of financial intermediaries to supply credit to the economy” and further weigh on overall economic activity.
  • Despite ongoing concerns about CRE, the Fed survey also found that the issuance of non-agency securities started to recover in the first three months of 2024.
  • A separate report from DoubleLine shows signs of improvement for the commercial mortgage-backed securities market and other capital markets and notes that borrowers in some sectors, including office, are finding access to credit. (Bloomberg, April 24)

The Roundtable’s all-member June 20-21 Annual Meeting will include a Joint Research Committee and Real Estate Capital Policy Advisory Committee Meeting to drill down into specific CRE capital and credit market trends and issues.

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Fed Cautions About Office Sector as Vacancies Climb and Loan Modifications Surge

La Salle Street, Chicago, Illinois, USA

Recent reports show U.S. office vacancies climbed to nearly 20% during Q1 2024 after loan modifications more than doubled last year compared to 2023. Meanwhile, Federal Reserve Board Vice Chair for Supervision Michael Barr cautioned this week that federal regulators are “looking carefully at banks with heavy concentrations in office commercial real estate where there are significant, expected price declines.” (Moody’s Analytics, April 2 | CRED iQ, March 28 | (C-SPAN video, April 3)

Office Sector

  • Preliminary data from Moody’s Analytics reinforces the long-term, negative ramifications of hybrid work models. The Q1 2024 office vacancy rate set a new record at 19.8%, up from 19.6% in the prior quarter, and beating two historic peaks of 19.3% in 1986 and 1991. (Bloomberg, April 2 | Quartz, April 3 | CRE Daily, April 4)
  • “The office stress isn’t quite done yet,” said Thomas LaSalvia, Moody’s head of commercial real estate economics and an author of the report. He added, “This is part of a longer-term evolution where we are seeing obsolete buildings in obsolete neighborhoods.” (Bloomberg, April 2)
  • Brookfield’s Feb. 14 report, “The Misunderstood U.S. Office Market,” emphasizes that high vacancy rates are due to an excess of dated, functionally obsolete office buildings and an undersupply of offices that satisfy tenants’ changing needs.
  • A Roundtable-led coalition of 16 national real estate organizations urged the expansion of a 20 percent tax credit for qualified property conversion expenditures in an Oct. 12, 2022 letter to policymakers. The recommended enhancements included expanding the category of properties eligible for the credit to various types of commercial buildings such as shopping centers and hotels. (Roundtable Weekly, Nov. 11, 2022)

Fed Oversight & CRE Sectors

Federal Reserve Board Vice Chair for Supervision Michael Barr
  • The Fed’s top market supervisor told the National Community Reinvestment Coalition on April 3 that CRE refinancing deals will “take some time to work through” as the Fed closely monitors office sector conditions. (C-Span | BGov, April 3 | Roundtable Weekly, March 8)
  • Barr said, “This is the kind of thing where it is likely a slow-moving train as the financial sector and commercial real estate market move forward. Over the next two to three years, we are going to see how properties deal with refinancing in a higher interest rate environment. Occupancy rates have lowered because of work-from-home, so for some categories of office CRE they are more exposed to risk.”
Kathleen McCarthy
  • Kathleen McCarthy, global co-head of Blackstone Real Estate and chair-elect of The Real Estate Roundtable, commented to CNBC’sClosing Bell Overtime” on April 3 that the office sector is different from other CRE investment areas that have performed well. “We do feel like there’s a bottoming happening. There’s no V-shaped recovery … but we do see the cost of capital coming down, we’re seeing more liquidity in markets, and perhaps more importantly for the long term, we’re seeing a sharp decline in new supply,” she said.
  • Barron’s recognized McCarthy this week as one of the 100 Most Influential Woman in Finance. She commented on her upcoming role as Roundtable Chair: “To bring together my interest in policy and have a position to help our whole industry in Washington is really exciting.” (Barron’s, April 4)

Commercial and multifamily market conditions will be discussed during RER’s April 15-16 Spring Meeting in Washington DC (Roundtable-level members only) with guests including White House Council of Economic Advisers Chairman Jared Bernstein,  House Democratic Leader Hakeem Jeffries (D-NY), and House Financial Services Member French Hill (R-AK). 

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Potential CRE Losses Cited as Major Economic Concern in Fed’s Financial Stability Report

Elevated commercial real estate valuations are increasingly viewed as a near-term risk that could stress the U.S. financial system, according to the Federal Reserve’s October 2023 Financial Stability Report. The central bank’s semiannual report also cited inflationary pressures, interest rate increases, and global economic volatility as vulnerabilities—even though survey data was collected before the recent escalation of geopolitical tensions in the Middle East. (Fed’s Financial Stability Report, Oct. 2023)

CRE Risk Emphasized

  • Seventy-two percent of all participants in the Fed’s survey cited the potential for large losses on commercial real estate and residential real estate—along with persistent inflation and monetary tightening­—as major risks.
  • The CRE asset valuation problem noted in the Fed Report is influenced by an ongoing lack of price discovery, which creates significant refinancing challenges. GlobeSt reported Oct 24 on the report, noting that “With transactions down and many sellers holding off, waiting for improved pricing while a lot of buyers look for bargains in distress, it’s hard to tell how much properties should be worth.”

WorkPlace Return Pressure

  • The Fed report warns, “If the economy were to slow unexpectedly … investor risk appetite and asset prices might decline, and valuations in the office building sector appear particularly vulnerable given the ongoing uncertainty surrounding post-pandemic norms regarding return to work. A correction in office property valuations accompanied by even a mild recession could result in significant losses for a range of financial institutions with sizable exposures, including some regional and community banks and insurance companies.”

Additional risks that continued to feature prominently in the Fed survey were associated with the reemergence of banking-sector stress, market liquidity strains, and volatility.

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Senate Bill Introduced to Define Federal Remote Work Roles; GSA Inspector General to Investigate Agency Telework Policies

Sens. James Lankford (R-OK) and Kyrsten Sinema (I-AZ) recently introduced the Telework Reform Act to codify government definitions of remote work and improve the accountability and transparency of federal telework programs. Meanwhile, the Inspector General of the General Services Administration (GSA) confirmed an audit is underway that is focused on how the agency manages telework and remote positions for over one million federal workers. (Lankford news release, Oct. 12 | Senate bill S. 3015) | Washington Times, Oct. 18)

Congressional Efforts

  • The Senate legislation would require teleworking federal employees to return to their offices at least twice per two-week pay period. The bill also includes measures that would enforce annual reviews of telework agreements, mandate training for managers, and improve performance management, data accuracy, and cyber-security. (Government Executive, Oct. 13 and Federal News Network, Oct. 17)
  • Separately, Sen. Joni Ernst (R-IA) is seeking to add an amendment to federal spending bills that would force agencies to provide details on the cost of telework. “There’s no better way to start paying off our nation’s over $33 trillion debt than a clearance sale on unused office space.” (Washington Times, Oct. 18 | BGov, Sept. 14)

  • A recent letter from the GSA’s Inspector General to Sen. Ernst confirmed the IG’s oversight investigation into the agency’s telework policies. (Washington Times, Oct. 18)
  • As the largest landlord in the United States, GSA’s Public Buildings Service (PBS) owns and leases more than 8,800 assets and maintains an inventory of more than 370 million square feet of rentable workspace. (GSA Strategic Plan Fiscal Years 2022-2026)
  • The Senate actions come as a House subcommittee announced it will hold a second hearing on federal agencies’ post-pandemic telework policies. (See Roundtable Weekly, Sept. 15 for coverage of the first hearing).
  • Language similar to the SHOW UP Act is included in House-passed appropriations legislation. (Roundtable Weekly, Sept. 15)

Roundtable Advocacy

  • The Real Estate Roundtable has urged President Biden and national policymakers for months to end government policies that encourage remote working arrangements for federal employees. (RER letter to President Biden, Dec. 2022; RER letter to Senate, April 2023)
  • In April, the White House Office of Personnel Management announced it was ending its “maximum telework” directive to federal agencies (Roundtable Weekly, April 21)
  • In August, the White House ordered Cabinet officials to increase the return of federal employees to their offices. (Roundtable Weekly, Aug. 11)

Real Estate Roundtable President and CEO Jeffrey DeBoer, repeatedly has emphasized that remote working by federal employees is undermining the health of cities, local tax bases, and small businesses. (Commercial Observer and The Hill, April 14) 

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White House Directs Agencies to Increase Return of Employees to Federal Offices

White House Chief of Staff Jeff Zients

White House Chief of Staff Jeff Zients, above, directed Cabinet officials on Aug. 4 to increase the return of federal employees to their offices this fall as a “critical” part of fulfilling the mission of government agencies. The Real Estate Roundtable has urged President Biden and national policymakers for months to end government policies that encourage remote working arrangements for federal employees. (Government Executive, Aug. 7 | Axios, Aug. 4 | RER letter to President Biden, Dec. 12, 2022)

Back-to-Office Fed Policies

  • Zients informed administration officials, “As we look towards the fall, your agencies will be implementing increases in the amount of in-person work for your team. This is a priority of the president — and I am looking to each of you to aggressively execute this shift in September and October.” (Reuters, Aug 5 and The Washington Post, Aug. 4)
  • Empty federal offices have depressed local economies, according to a July 18 Federal News Network (FNN) broadcast. (Listen or read transcript from Federal Drive with Tom Temin)
  • An updated list of agencies’ return-to-office policies is available online through the Federal News Network. Meanwhile, Republican leaders on the House Oversight and Accountability Committee have also urged agency officials to encourage a return-to-office, threatening this week to “resort to compulsory measures” in their probe of federal agencies’ telework polices.

Roundtable Weighs In Real Estate Roundtable President and CEO Jeffrey DeBoer

  • In an April letter to all U.S. Senators, Real Estate Roundtable President and CEO Jeffrey DeBoer, above, emphasized, “The executive branch’s current policies are undermining the health of cities, local tax bases, and small businesses. Federal agencies should return to their pre-pandemic workplace practices.” (RER letter to the Senate, April 12).

In a similar letter to President Biden in December, DeBoer noted that federal telework policies were ignoring “the negative impacts of remote work on cities and communities, labor productivity, and U.S. economic competitiveness, as well as the quality of government services.” (Commercial Observer, April 14 and RER letter to President Biden, Dec. 12)

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OPM Ends “Maximum Telework” Status for Federal Government

U.S. Office of Personnel Management logo

On Tuesday, the White House Office of Personnel Management (OPM) announced that it is ending its “maximum telework” directive to federal agencies. 

Federal Workforce and Telework

  • At the outset of the pandemic, OPM issued a government-wide announcement that federal agencies should “operate as ‘open with maximum telework flexibilities to all current telework eligible employees…'” The April 18 memo from OPM Director Kiran Ahuja states that OPM will withdraw its maximum telework directive effective May 15, 2023. (Gov’t. Executive, Apr 19)

  • “COVID-19 is not driving decisions regarding how Federal agencies work and serve the public as it was at the outset of the pandemic,” wrote Director Ahuja in his memo to the chief human capital officers of federal agencies.
  • The announcement by OPM comes on the heels of guidance released last week from the White House Office of Management and Budget (OMB) informing federal agencies that they have 30 days to develop plans to “substantially increase” their employees in-person work at headquarters.

Roundtable Letters Jeff DeBoer RER Meeting

  • Both the OMB and OPM actions followed appeals from The Real Estate Roundtable for the federal government to end its “active encouragement of remote working for federal employees.” (RER letter to the Senate).
  • “The executive branch’s current policies are undermining the health of cities, local tax bases, and small businesses. Federal agencies should return to their pre-pandemic workplace practices,” wrote Real Estate Roundtable President and CEO Jeffrey DeBoer, above, in an April 12 letter to all U.S. Senators. 

  • In a similar letter to President Biden in December, DeBoer wrote that federal telework polices were ignoring “the negative impacts of remote work on cities and communities, labor productivity, and U.S. economic competitiveness, as well as the quality of government services.”  (Commercial Observer, April 14 and RER letter to President Biden).

  • “This week’s OPM announcement is another important step forward for our communities, small businesses, and local tax bases that depend on vibrant city centers,” said DeBoer. (Roundtable Weekly, April 14)

Low Office Occupancy Persists Empty office

  • Kastle reported on Monday that office occupancy rates for 10 U.S. cities fell to an average of 46%, a weekly dip of 2.2 points that reflects consistent rates of under 50% since last month. (Kastle’s Back to Work Barometer, April 17)
  • Real estate investor Sam Zell commented this week on the state of the office market and remote work, predicting a reversal in telework trends. (GlobeSt, April 20)
  • “We’re all reading about layoffs in the newspapers. It will be interesting to see what percentage of those who lost their jobs worked from home and what percentage of them are people who came into the office,” said Zell. “The office situation will change. People need to be together to develop their skills.”

The impact of return-to-the office on the industry, communities, and the economy will be a focus of discussion during The Roundtable’s April 24-25 Spring Meeting in Washington, DC. (Roundtable-level members only). 

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